A Complete Guide To Credit Risk Modelling PDF

6/1/2020 A Complete Guide to Credit Risk Modelling
ABOUT INDEX CONTACT
HOME SAS R PYTHON DATA SCIENCE CREDIT RISK SQL EXCEL SPSS
INFOGRAPHICS
SEARCH... GO
Home » Credit Risk Modeling » A Complete Guide to Credit Risk Modelling  Get Free
Email Updates
A COMPLETE GUIDE TO CREDIT RISK MODELLING  Follow us on
Deepanshu Bhalla 8 Comments Credit Risk Modeling
Facebook
This article explains basic concepts and

methodologies of credit risk modelling and how it is
important for nancial institutions. In credit risk
world, statistics and machine learning play an
important role in solving problems related to credit
risk. Hence role of predictive modelers and data
scientists have become so important. In banking
under analytics division, it's one of the highest paid
job.
Table of Contents ✖
 Love this Post? Spread the Word!
1. What is Credit
 Share  ShareRisk?  Tweet  Subscribe
https://www.listendata.com/2019/08/credit-risk-modelling.html 1/30
2. Why Credit Risk is important?
3. Basel Regulations
1. Basel I
2. Basel II
3. Basel III
4. IFRS 9
Cost-E e
1. How IFRS 9 is different from Basel
Python Co
III? The World’s top
are hiring ce i
5. What is Credit Risk Modelling?
Python develop
6. Probability of Default Modeling your ce i cate
1. De ne Dependent Variable Edureka

2. Methodologies for Estimating PD
3. Data Sources for PD Modeling

Open
4. Steps of PD Modeling
5. Statistical Techniques used for

Model Development
6. Model Performance in PD Model
7. Rating Philosophy
8. Credit Scoring and Scorecard
7. Important Terminologies related to Credit

Risk
8. Lifetime PD vs 12 month PD
9. Macroeconomic factors to consider to

✖
estimate
 Love this ECL the Word!
Post? Spread
 Share  Share  Tweet  Subscribe
10. Softwares used in risk analytics
What is Credit Risk?

In simple words, it is the risk of borrower not
repaying loan, credit card or any other type of loan.
Sometimes customers pay some installments of
loan but don't repay the full amount which includes
principal amount plus interest. For example, you
took a personal loan of USD 100,000 for 10 years at
9% interest rate. You paid a few initial installments
of loan to the bank but stopped paying afterwards.
Remaining unpaid installments are worth USD
30,000. It's a loss to the bank.
It's not restricted to retail customers but includes

small, medium and big corporate houses. In news,
you might have heard of King sher Company
became non-performing asset (NPA) which means
the company had not been able to pay dues. High
NPAs lead to huge nancial losses to the bank
which turns to reduction of interest rate on the
deposit into banks. Serious honest borrowers with
good credit history (credit score) would have to
suffer. Hence it is essential that banks have
su cient capital to protect depositors from risks
✖
Why Credit Risk is important?

Do you remember or aware of 2008 recession? In
US, mortgage home loan were given to low
creditworthy customers (individuals with poor credit
score). Poor credit score indicates that one is highly
likely to default on loan which means they are risky
customers for bank. To compensate risk, banks
used to charge higher interest rate than the normal
standard rate. Banks funded these loans by selling
them to investors on the secondary market. The
process of selling them to investors is a legal
nancial method which is called Collateralized debt
obligations (CDO) . In 2004-2007, these CDOs were
considered as low-risky nancial instrument (highly
rated).
As these home loan borrowers had high chance to

default, many of the them started defaulting on their
loans and banks started seizing (foreclose) their
property. The real estate bubble burst and a sharp ✖
 Love this
decline Post? Spread
in home prices.the Word!nancial
Many institutions
globally invested in these funds resulted to a

recession. Banks, investors and re-insurers faced
huge nancial losses and bankruptcy of many
nancial and non- nancial rms. Even non- nancial
rms were impacted badly because of either their
investment in these funds or impacted because of a
very low demand and purchasing activities in the
economy. In simple words, people had a very little or
no money to spend which leads to many
organisations halted their production. It further
leads to huge job losses. US Government bailed out
many big corporate houses during recession. You
may have understood now why credit risk is so
important. The whole economy can be in danger if
current and future credit losses are not identi ed or
estimated properly.
Basel Regulations
A committee was set up in year 1974 by central
bank governors of G10 countries. It is to ensure that
banks have minimum enough capital to give back
depositors’ funds. They meet regularly to discuss
banking supervisory matters at the Bank for
International Settlements (BIS) in Basel, Switzerland.
The committee was expanded in 2009 to 27
jurisdictions, including Brazil, Canada, Germany,
Australia, Argentina, China, France, India, Saudi
Arabia, the Netherlands, Russia, Hong Kong, Japan,
✖
Italy,
 LoveKorea, Mexico,
this Post? Singapore,
Spread the Word! Spain, Luxembourg,
Turkey, Switzerland,
 Share Sweden, South
 Share Africa, the
 Tweet  Subscribe
United Kingdom, the United States, Indonesia and

Belgium.
Basel I
Basel I accord is the rst o cial pact introduced in

year 1988. It focused on credit risk and introduced
the idea of the capital adequacy ratio which is also
known as Capital to Risk Assets Ratio. It is the ratio
of a bank's capital to its risk. Banks needed to
maintain ratio of at least 8%. It means capital should
be more than 8 percent of the risk-weighted assets.
Capital is an aggregation of Tier 1 and Tier 2 capital.
1. Tier 1 capital : Primary funding source of the

bank. It includes shareholders' equity and
retained earnings
2. Tier 2 capital : Subordinated loans,

revaluation reserves, undisclosed reserves
and general provisions
In Basel I, xed risk weights were set based on the

level of exposure. It was 50% for mortgages and
100% for non-mortgage exposures (like credit card,
overdraft, auto loans, personal nance etc). See the
example shown below -
Mortgage $5,000
Risk Weight 50%
Risk Weighted Assets $2500 (Mortage * Risk Weight)
✖
 Minimum
Love thisCapital
Post? Required $200
Spread the (8% * Risk Weighted Assets)
Word!
Basel II
Basel II accord was introduced in June 2004 to

eliminate the limitations of Basel I. For example,
Basel I focused only on credit risk whereas Basel II
focused not only credit risk but also includes
operational and market risk. Operational Risk
includes fraud and system failures. Market risk
includes equity, currency and commodity risk.
In Basel II, there are following three ways to

estimate credit risk.
Standardized Approach
Foundation Internal Rating Based (IRB)
approach
Advanced Internal Rating Based (IRB)
Approach
Standardized Approach
For corporate, the banks relies on ratings from

certi ed credit rating agencies (CRAs) like S&P,
Moody etc. to quantify required capital for credit
risk. Risk weight is 20% for high rated exposures and
goes up to 150 percent for low rated exposures. For
retail, risk weight is 35% for mortgage exposures
and 75% for non-mortgage exposures (no rating by
credit rating agencies required for retail).
✖
Corporate Exposure $5,00,000
Credit Assessment AAA
Risk Weights 20%

Risk Weighted Assets $1,00,000
Minimum Capital Required $8,000
Internal Ratings Based (IRB) Approach
It has four credit risk components :
Probability of Default (PD)

Exposure at Default (EAD)
Loss given Default (LGD)
Effective Maturity (M)
Probability of Default (PD)
Probability of default means the likelihood that a

borrower will default on debt (credit card, mortgage
or non-mortgage loan) over a one-year period. In
simple words, it returns the expected probability of
customers fail to repay the loan. Probability is
expressed in the form of percentage, lies between
0% and 100%. Higher the probability, higher the
chance of default.
Exposure at Default (EAD)
It means how much should we expect the amount

outstanding to be in the case of default. It is the
amount that the borrower has to pay the bank at the
time of default.
Loss given Default (LGD)

✖
It means how much of the amount outstanding we

expect to lose. It is a proportion of the total
exposure when borrower defaults. It is calculated by
(1 - Recovery Rate).
LGD = (EAD – PV(recovery) – PV(cost)) / EAD

PV (recovery)= Present value of recovery discounted till time of
default.
PV (cost) = Present value of cost discounted till time of default.
Expected Loss
Expected Loss is calculated by (PD * LGD * EAD).
Example
Someone takes $100,000 home loan from bank for

purchase of at. At the time of default, loan has an
outstanding balance of $70,000. Bank foreclosed
at and sold it for $60,000. EAD is $70,000. LGD is
calculated by dividing ($70,000 - $60,000)/$70,000
i.e. 14.3%.
Probability of Default 2%
Exposure at Default $20,000
Loss Given Default 20%
Expected Loss $80
Foundation and Advanced IRB Approach
There are two types of Internal Rating Based (IRB)

approaches which are Foundation IRB and
✖
Advanced
 Love this IRB.
Post? Spread the Word!
Foundation IRB Advanced IRB

PD is estimated PD, LGD, and EAD
internally by the can be estimated
bank while LGD and internally by the
EAD are prescribed bank itself.
by regulator.
Effective Maturity (M)
It is a duration that re ects standard bank practice

is used. For Foundation IRB, the effective maturity is
2.5 years (exception is repo style transactions where
it is 6 months). For Advanced IRB, M is the greater
of 1 year or the effective maturity of the speci c
instrument.
Basel III
Basel III accord has recently become effective

starting 2019. In some countries, central banks have
xed Dec'2019 as the deadline to meet capital
requirements under the Basel III norm. Basel III has
incorporated several risk measures to counter
issues which were identi ed and highlighted in 2008
nancial crisis. It emphasis on revised capital
standards (such as leverage ratios), stress testing
and tangible equity capital which is the component
with the greatest loss-absorbing capacity.
✖
The concept of building internal

models and external ratings for
estimating PD, LGD and EAD remains
same as it was in Basel II. However
there are some changes introduced in
Basel III. It is shown in the table below.
Basel II Basel III
Common Tier 1 capital ratio(shareholders’ 2% * 4.5% *

equity + retained earnings) RWA RWA
4% * 6% *
Tier 1 capital ratio
RWA RWA
4% * 2% *
Tier 2 capital ratio
RWA RWA
2.5% *
Capital conservation buffer(common equity) -
RWA
IFRS 9
IFRS 9 is is an International Financial Reporting
Standard dealing with accounting for nancial
instruments. It replaces IAS 39 Financial
Instruments which was based on the incurred loss
model whereas IFRS 9 focuses on the expected loss
model that covers also future losses.
In IFRS 9, the idea is to recognize 12-

month loss allowance at initial
✖
recognition
 Love this andthe
Post? Spread lifetime
Word! loss
allowance on signi cant increase in

credit risk
Python Online
Course
2019 is the best time to
improve your Python
programming skills. Get
sta ed today
Edureka Open
As per IFRS 9, there are three stages of Credit Risk

which are as follows -
1. Stage 1 - Credit risk has not increased

signi cantly since initial recognition,
indicates low credit risk at reporting date
2. Stage 2 - Credit risk has increased

signi cantly since initial recognition
3. Stage 3 - Permanent reduction in the value of

nancial asset at the reporting date
How IFRS 9 is different from Basel

III?
Yes, they are different but both requires building PD,
LGD and EAD models. See the difference between
them below.
✖
Parameters Basel III IFRS 9
Objective Expected + Expected Loss

Unexpected
Loss
12 month PD for stage 1

PD One year PD assets, Lifetime PD for
stage 2 and 3 assets
Rating TTC rating

PIT rating philosophy
Philosophy philosophy
Downturn LGD
Best estimate LGD (only
LGD (both direct +
direct costs)
indirect costs)
EAD Downturn EAD Best estimate EAD
Expected Loss
/Expected EL=PD*LGD*EA EL=PD*PV of cash
CreditLoss D shortfalls
(ECL)
What is Credit Risk Modelling?

Credit risk modeling refers to data driven risk
models which calculates the chances of a borrower
defaults on loan (or credit card). If a borrower fails
to repay loan, how much amount he/she owes at the
time of default and how much lender would lose
from the outstanding amount. In other words, we
need to build probability of default, loss given
default and exposure at default models as per
advanced IRB approach under Basel norms.
Probability of Default Modeling

In this section, we covered various steps and ✖
methods
 Sharerelated
toShare
PD modeling.
De ne Dependent Variable
Binary variable having values 1 and 0. 1 refers to bad
customers and 0 refers to good customers.
Bad Customers Customers who defaulted in

payment. By 'default', it means if either or all of the
following scenarios have taken place.
Payment due more than 90 days. In

some countries, it is 120 or 180 days.
Borrower has led for bankruptcy
Loan is partially or fully written off
Indeterminates or rollovers These customers fall into

these 2 categories :
Payment due 30 or max 60 days but paid

after that. They are regular late payers.
Inactive accounts
All the other customers are good customers .
Indeterminates should not be included as it would

reduce the discrimination ability to distinguish
between good and bad. It is important to note that
we include these customers at the time of scoring.
We consider 12 months as performance window to

ag defaults which means if a customer has ✖
defaulted
 Love thisany time
Post? in next
Spread 12 months,
the Word! it would be
agged as 'Bad'
Methodologies for Estimating PD

There are two main methodologies for estimating
Probability of Default.
1. Judgmental Method
2. Statistical Method
Judgmental Method
It relies on the knowledge of experienced credit

professionals. It is generally based on ve Cs of the
applicant and loan.
Character : Check credit history of

borrower. If no credit history, bank can
ask for referees who bank can contact to
know about the reputation of borrower.
Capital : Calculate difference between
the borrower’s assets (e.g., car, house,
etc.) and liabilities (e.g., renting
expenses, etc.)
Collateral : Value of the collateral
(security) provided in case borrower fails
to repay
Capacity : Assess borrower’s ability to
pay principal plus interest amount by
checking job status, income etc.
Conditions includes internal and external
factors (e.g. economic recession, war,
natural calamities etc.)
Judgmental methods have become ✖

past as Statistical
 Share  Share methods are more
popular these days. But it is still

widely used when historical data is
not available (especially new credit
products).
Statistical Method
In today's world, nobody has time to wait for 1-2

months to know about the status of loan. Also many
borrowers apply for loan through bank's website.
Hence real-time credit decisions by bank is required
to remain competitive in the digital world. The
advantage of using statistical method is that it
produces mathematical equation which is an
automated and faster solution for making credit
decisions.
This method is unbiased and free from dishonest or

fraudulent conduct by loan approval o cer or
manager.
This method also comes with higher accuracy as

statistical and machine learning models considers
hundreds of data points to identify defaulters.
Data Sources for PD Modeling

Demographic Data : Applicant's age,
income, employment status, marital
status, no. of years at current address, ✖
 Loveno.
thisofPost?
years at job,
Spread thepostal
Word! code
Existing Relationship : Tenure, number of

products, payment performance,
previous claims
Credit Bureau Variables : Default or
Delinquency history, Bureau score,
Amount of credits, Inquiries etc.
Steps of PD Modeling
Data Preparation
Variable Selection
Model Development
Model Validation
Calibration
Independent Validation
Supervisory Approval
Model Implementation : Roll out to users
Periodic Monitoring
Post Implementation Validation :
Backtesting and Benchmarking
Model Re nement (if any issue)
Statistical Techniques used for

Model Development
Logistic Regression is most widely used
technique for estimation of PD
Survival Analysis is generally used to
compute lifetime PD (required for IFRS 9)
Random Forest
✖
 LoveGradient Boosting
this Post? Spread the Word!
Markov chain Modeling
Neural Network
Model Performance in PD Model

There are main 2 levels of performance testing -
1. Discrimination : Ability to differentiate

between good (non-defaulters) and bad
(defaulters) customers
2. Calibration : Check whether the actual default

rate is close to predicted PD values
Statistical Tests for Model Performance
Discrimination : Area under Curve, Gini coefficient, KS Statistics

Calibration : Hosmer and Lemeshow Test, Binomial Test
Check out this link for detailed explanation : Model

Performance Simpli ed
Rating Philosophy
It refers to the time horizon for which ratings
measure credit risk and how much they are
in uenced by cyclic effects.
Point in time (PIT) PD Through the cycle
It (TTC) PD
evaluates It
the predicts
chances average
of default default ✖
at Post?
 Love this that Spread the Word! rate over
point in  Share
 Share  Tweet
an  Subscribe
time. It economi
consider c cycle
s both and
current ignores
macro- short run
economi changes
c factors to a
and risk customer
attributes 's PD and
of closely
borrower. resemble
s long-
Since it
term
captures
average
current
default
macro-
rate.
economi
c factors Grade
so PIT assigned
PD is not
moves up depende
as nt on
macro- current
economi macro-
c economi
condition c factors
s
It
deteriorat
focuses
e and on long-
moves run
down as average
macro- PD
economi
c Basel III
condition requires
s PDs to be ✖
 Love this Post? Spread the Word! Through
improve.
 Share  Share  Tweet
the cycle Subscribe
It
focuses
on
reporting
date
IFRS 9
requires
PDs to be
Point in
time
In general, hybrid model (considering both PIT and

TTC) is used.
Credit Scoring and Scorecard

Probability of Default model is used to score each
customer to assess his/her likelihood of default.
When you go to Bank for loan, they check your credit
score. This credit score can be built internally by
bank or Bank can use score of credit bureaus.
✖
Credit Bureaus collect individuals' credit information
from various banks
 Share and sell it in
 Share the form ofaSubscribe
Tweet credit
report. They also release credit scores. In US, FICO

score is very popular credit score ranging between
300 and 850. In India, CIBIL score is used for the
same and lie between 300 and 900.
Types of Scorecards
1. Application Scorecard : It applies to new ( rst

time) customers applying for loan or credit card. It
estimate probability of default at time applicant
applies for loan. See the example below how it
works.
Suppose cutoff for granting loan = 350
Profile of a New Customer

Age 30
Gender Male
Salary 15000
Total Points = (100 + 85 + 120) = 305

Decision : Refuse Loan
✖
Data required for application scorecard
We use customer's application or demographic data

along with credit bureau data. There is no
observation window for historical data as these are
new customers. De nition of Bad is same which is
90+ days past due. Performance window is
generally 12 to 24 months from opening account.
Application scorecard is used majorly for the

following tasks:
To determine whether or not to approve a

customer for a loan.
To assist in 'due diligence'. Suppose an
applicant scoring very high or very low
can be declined or approved outright
without asking for further information.
2. Behavior Scorecard : It applies to existing

customers to assess whether customer will default
in loan payment. Performance window is generally 6
to 18 months.
Behavior scorecard is used majorly for the following

tasks:
To set credit limit i.e. increase or

decrease credit limit
Debt provisioning and pro t scoring.
Renewals
✖
Difference
 between
Love this Post? Spread Application
the Word! and Behavior
 Share
Scorecard  Share  Tweet  Subscribe
Application scorecard is applied on new customers

(generally lower than 1 year) whereas Behavior
scorecard is applied on existing customers (greater
than 1 year). For application scorecard, we don't
require well-calibrated default probabilities. But
calibrated default probabilities are required for
behavior scorecard as per Basel norms. These two
scorecards are also different in terms of usage. See
the explanation above in their respective section
how they are generally used.
Collections Scoring
It predicts probability that a loan already late for a

given number of days will be late for another given
number of days. They are typically built for
performance windows of one month.
Desertion Scoring
It predicts the probability a borrower will apply for a

new loan once the current loan is paid off. ✖
Important Terminologies related to

Credit Risk
Stressed PD vs. Unstressed PD
Stressed PD: A stressed PD depends on the risk

attributes of borrower but is not highly affected by
macroeconomic factors as adverse economic
conditions are already factored into it.
Unstressed PD: An unstressed PD depends on both

current macroeconomic and risk attributes of
borrower. It moves up or down depending on the
economic conditions.
Downturn LGD and EAD
Under Basel II and III, nancial institutions need to

estimate downturn LGD and EAD. By 'downturn', it
means at least two consecutive quarters of negative
growth in real GDP. It is required because LGD and
EAD can be affected by downturn economic
conditions.
Conditional PD
It is the probability of default during the second year

given that it does not default during the rst year. To
calculate conditional PD, we need probability of not
defaulting by the end of year 1 (P0) and
unconditional probability of defaulting during the
✖
second
 year
Love this (P1).
Post? If P0=0.5
Spread and
the Word! P1=0.1 so
Conditional PD i.e. Prob(default | Survival) would be

0.1/0.5 = 20%
Lifetime PD vs 12 month PD
As per IFRS 9, we require two types of PDs for
calculating expected credit losses (ECL).
12-month PDs for stage 1 assets -

Chances of default within the next 12
months
Lifetime PDs for stage 2 and 3 assets -
Chances of default over the remaining
life of the nancial instrument.
Suppose 12-month PD is 3% which means survival rate is 97%

(1 - PD). 2nd and 3rd year conditional PD is 4% and 5%.
1st year cumulative survival rate (CSR) is same as first year
survival rate (SR).
2nd year cumulative survival rate = 1st year CSR * SR of 2nd
year = 97% * 96% = 93%
3rd year cumulative survival rate = 2nd year CSR * SR of 3rd
year = 93% * 95% = 88%
Lifetime PD = 1 - 88% = 12%
Macroeconomic factors to consider

to estimate ECL
GDP
Unemployment rate
Index of Industrial Production
Import
Export
Interest rate ✖
Inflation rate
House price index
Exchange rate
Softwares used in risk analytics

Let's split this section into two parts -
1. Data Extraction
Most of the data is stored in relational databases
(SQL Server, Teradata). Analyst need to have expert
level knowledge of SQL to extract or manipulate
data. Data is not saved in a single SQL table or
database. In order to extract relevant data elds
from database, you need to select multiple tables
and join them based on matching key(s). During this
process, you need to apply some business rules
(excluding some type of customers or accounts).
Transaction table is generally in mainframe
environment so basic knowledge of mainframe and
UNIX would be key. Mainframe and UNIX are not
primary skill sets banks generally look for in risk
analyst (It's good to have!). Developers are generally
hired for this work.
2. Model Building
SAS is the most widely used software in risk
analytics. Despite huge popularity of R and Python
these days, more than 90% of banks and other
nancial institutions still use SAS. Banks also
started exploring R and Python. They are building (or ✖
already built) syntax
 Share library (repository)
 Share  Tweet in Rand
Subscribe
Python language for credit risk projects.
SAS can be easily integrated with relational

databases and mainframe. Many companies
execute both data extraction and model building
steps in SAS environment only.
End Note
Hope you have got a fair idea of how predictive

modeling is used in credit risk domain and what are
the key credit risk parameters. In risk analytics,
domain knowledge is more important than technical
or statistical knowledge. Hope this article helped
you in lling that gap. Please provide your feedback
in the comment box below.
 SUBSCRIBE TO GET EMAIL UPDATES!
Related Posts
Gini, Cumulative
Accuracy Pro le, AUC
Weight of Evidence and
Information Value for
Continuous Dependent
Variable
Loan Amortisation ✖
 LoveSchedule using the
this Post? Spread R Word!
and
 Share
Python  Share  Tweet  Subscribe
Roll Rate Analysis

Credit Risk: Vintage
Analysis
About Author:
Deepanshu founded ListenData with a simple objective - Make analytics
easy to understand and follow. He has over 8 years of experience in data
science. During his tenure, he has worked with global clients in various
domains like Banking, Insurance, Telecom and Human Resource.
While I love having friends who agree, I only learn from those who don't
Let's Get Connected: Email | LinkedIn
8 Responses to "A Complete Guide to Credit Risk Modelling"
Get Ce i ed in 4 Weeks
Learn with the help of industry case-

projects using Python
Edureka
Unknown 5 September 2019 at 21:20
Hi Deepanshu really very informative for beginner's like me....

Can you please example of how behavior score card can be used to
set credit Limit
Reply
Replies
Jisu 24 September 2019 at 07:28
Behaviour score generated based on customer ✖

history(Transaction, Delinquent,overlimit or past due or
loan defaulter or credit card credit limit utilization. So in
 Share that Share
case good
if BEH score is Tweet
that means, He/she
Subscribe
is a
good customer. So bank can use this beh score range and
can increase credit limit
Reply
Unknown 9 September 2019 at 22:20
Hi Deepanshu
could you explain the risk weight and how will they set the threshold
Reply
Bawa Anshuman Singh 22 September 2019 at 07:28
Amazing ! Im working in credit risk reporting and I haven't yet come

across such a concise and clear theoretical background
Reply
Replies
Deepanshu Bhalla 1 October 2019 at 11:10
Glad you found it useful. Cheers!
Reply
Unknown 27 March 2020 at 11:15
Very useful content..I have been working in banking sector last 5

years, but still it clarified few concept for me..kudos to you for
enlighten people.
Reply
Anonymous 30 March 2020 at 13:57
In credit risk we "snapshot" and "vintage" are commonly used. Is

there any difference between snapshot and vintage or are these
used interchangeably?
Reply
Kishore 14 April 2020 at 20:08
Good article, can you please provide pd, lgd models procedure end
to end
✖
Reply
Enter your comment...
Comment as: avanish (Googl Sign out
Publish Preview Notify me
← PREV NEXT →
Copyright 2019 ListenData
✖

A Complete Guide To Credit Risk Modelling PDF

Uploaded by

Copyright:

Available Formats

A Complete Guide To Credit Risk Modelling PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

A Complete Guide To Credit Risk Modelling PDF

Uploaded by

Copyright:

Available Formats

What is credit risk and why is it important for financial institutions?

What is credit risk and why is it important for financial institutions?

What factors led to the 2008 recession in the US?

What factors led to the 2008 recession in the US?

6/1/2020 A Complete Guide to Credit Risk Modelling

ABOUT INDEX CONTACT

This article explains basic concepts and

2. Why Credit Risk is important?

1. De ne Dependent Variable Edureka

3. Data Sources for PD Modeling

5. Statistical Techniques used for

6. Model Performance in PD Model

8. Credit Scoring and Scorecard

7. Important Terminologies related to Credit

9. Macroeconomic factors to consider to

What is Credit Risk?

It's not restricted to retail customers but includes

Why Credit Risk is important?

As these home loan borrowers had high chance to

globally invested in these funds resulted to a

United Kingdom, the United States, Indonesia and

Basel I accord is the rst o cial pact introduced in

1. Tier 1 capital : Primary funding source of the

2. Tier 2 capital : Subordinated loans,

In Basel I, xed risk weights were set based on the

Basel II accord was introduced in June 2004 to

In Basel II, there are following three ways to

For corporate, the banks relies on ratings from

Risk Weights 20%

Internal Ratings Based (IRB) Approach

It has four credit risk components :

Probability of Default (PD)

Probability of Default (PD)

Probability of default means the likelihood that a

Exposure at Default (EAD)

It means how much should we expect the amount

Loss given Default (LGD)

It means how much of the amount outstanding we

LGD = (EAD – PV(recovery) – PV(cost)) / EAD

Expected Loss is calculated by (PD * LGD * EAD).

Someone takes $100,000 home loan from bank for

Foundation and Advanced IRB Approach

There are two types of Internal Rating Based (IRB)

Foundation IRB Advanced IRB

Effective Maturity (M)

It is a duration that re ects standard bank practice

Basel III accord has recently become effective

The concept of building internal

Basel II Basel III

Common Tier 1 capital ratio(shareholders’ 2% * 4.5% *

In IFRS 9, the idea is to recognize 12-

allowance on signi cant increase in

As per IFRS 9, there are three stages of Credit Risk

1. Stage 1 - Credit risk has not increased

2. Stage 2 - Credit risk has increased

3. Stage 3 - Permanent reduction in the value of

How IFRS 9 is different from Basel

Objective Expected + Expected Loss

12 month PD for stage 1